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Globalization and its Challenges for Germany, Europe, and the IMF

January 10, 1997

97/1

Address by Michel Camdessus
Managing Director of the International Monetary Fund
at a conference sponsored by the Christian Social Union
Münich, Germany, January 10, 1997

It is quite a privilege for me to address this forum of the Christian Social Union. I must say that I
received with enthusiasm the invitation of Dr. Theo Waigel to speak here about globalization.
Coming from a man who plays such a crucial role at world level in helping the international
community face the challenges of our times, this invitation was a distinct honor.

At a time when so much attention in Germany--and in Europe--is focused on the requirements
of Economic and Monetary Union, it is essential not to lose sight of the broader issues concerning
Germany and Europe's role in the global economy. In helping to bring these issues to the fore, the
CSU is making an important contribution to the public debate. At the same time, the challenges of
globalization and those of EMU have much in common; thus, your discussions on "globalization"
can help bring some further insight into European issues, and vice versa.

Globalization is on the minds of policymakers around the world. The reasons for this are clear. As
we approach the beginning of the twenty-first century, the world economy is undergoing a
number of fundamental changes. Capital has achieved an unparalleled degree of mobility, and the
international financial markets are growing exponentially. World trade continues to expand
briskly, and investment and production decisions are now made by companies on a global basis.
Many new economic powerhouses have emerged, and the relative economic power of countries is
shifting. Indeed, virtually every country in the world is trying to come to terms with these changes
and what they will mean for their economies, their citizens, their cultures and ways of life. The
stakes are enormous: an unprecedented set, indeed, of opportunities and challenges.

Notwithstanding popular perceptions, globalization is a positive development for the world
economy, including industrial countries such as Germany. To begin with, globalization is the
continuation of the trend of growing openness and integration among economies that has brought
the world a half century of unparalleled prosperity. That openness is now being extended to
capital markets. The resulting flow of private capital to developing markets has not only helped
finance increased production in recipient countries; it has also helped sustain demand for industrial
country exports. For example, during 1990 to 1995, German exports to developing countries
increased by close to 10 percent per year on average in U.S. dollar terms, while German exports
to industrial countries increased by only 3 percent annually over the same period. As a result, by
1995, exports to developing countries represented 25 percent of total German exports, compared
to just 19 percent at the beginning of the decade.1 Consumers also benefit from globalization
through the wider choice of low-cost goods that increased trade specialization and trade
liberalization have helped make available.

Meanwhile, globalization offers investors in the international capital markets a wider range of
investment opportunities, higher returns on savings and greater portfolio diversification. For the
global economy as a whole, globalization promotes a more efficient allocation of resources
worldwide and, thus, higher world growth. Indeed, it is important to remember that during 1990-93, the dynamism of some 30 developing countries, strongly benefiting from these capital inflows,
helped cushion the impact of successive economic downturns in industrial countries, particularly
in Europe, and thus spare the world from a global recession.

But with these increased opportunities also come additional risks. Let me mention the most
pressing ones. The first is financial instability. The global economy has suffered several costly
financial crises over the last decade. Plunging asset prices, major bouts of exchange market
volatility, a crisis in emerging markets sparked by events in Mexico, and the collapse of several
major financial institutions, in industrial and emerging market countries alike, all underscore the
major weaknesses of our system. Thus far, the international community has been able to cope
with these episodes, but not without difficulty. Strengthening the financial system so that it can
better face such risks is then a must.

The second risk is that of marginalization. While some countries are harnessing the forces of
globalization to accelerate economic progress, others clearly are not. Indeed, countries that are
unable to participate in the expansion of world trade or attract significant amounts of private
investment run the risk of being left behind by the global economy. And the countries at greatest
risk of being marginalized are precisely those most in need of the trade, investment and growth
that globalization could bring. This raises the prospect of a widening gulf between countries that
are able to take advantage of globalization and those that are left by the wayside. The world
community cannot merely sit by and watch this happen, because it knows that it is now a unified
whole. It knows that a financial crisis, regardless of its origin, can become worldwide in a flash.
And it knows that it must not disregard the risk that marginalization entails for the world's
geopolitical equilibrium.

The third risk appears outside the economic sphere but deserves all our attention: can our
national, our regional cultures--such as the very vibrant one here in Bavaria--preserve their
unique value and traditional originality, when the forces of globalization seem to point toward
increasing cultural homogeneity?

Mr. Chairman, these opportunities and risks are with us, here in Germany, in Europe, and
worldwide. The particular responsibility of our generation is, of course, not just to take advantage
of these opportunities, but also to mobilize our imaginations and energies to change risks into new
opportunities. Let us see, then, what this implies for you in Germany, for us in Europe, for us in
the world.

* * * * *

What kind of a future can Germany expect in this era of globalization? Being a long-time admirer
of your unique record of economic achievement, I have every reason to look to your future with
confidence. Remember: 50 years ago, you were confronted with three major economic challenges:
to recreate a currency, to re-establish an economic and social order, and to build Europe. Your response was outstanding in
all three fields.

First, Germany has demonstrated the value of a stable currency as the key to a strong, durable and
equitable growth. Such an example, your example, has helped make monetary stability the
cornerstone of European economic policy, as well as the watchword of policymakers around the
world. I observe that a culture of stability is developing in Europe, possibly extending even
beyond your expectations. This, indeed, augurs well for the "first-class" quality of the euro
tomorrow.

Second, Germany has helped pioneer the concept of the social market economy, combining a
competitive, market economy with a unique social partnership that brought many years of
economic prosperity and social peace.

And third, Germany's steadfast commitment to the construction of Europe has helped promote
peace, stability and economic progress across the continent.

This is an impressive record on which to build. So why all the apprehension these days--in
Germany and, even more, elsewhere in Europe--about the future, about what globalization may
bring? Perhaps, it is precisely because globalization seems to challenge each of these three
achievements. To be sure, efforts to create a strong euro are coming to fruition at a time when the
power of global financial markets presents new challenges for the authorities responsible for
macroeconomic policy and, in particular, central banks. And now that the developed countries
have become accustomed to extensive social protection, globalization demands increasing
flexibility. Meanwhile, at a time when European policymakers are absorbed with preparations for
Economic and Monetary Union, the global economy continues to evolve in a less predictable way.
Competition in global markets is intensifying. Financial investments have become increasingly
diversified across countries to minimize risk and raise rates of return. At the same time, the
liberalization of trade and capital markets has made it far easier to shift production to locations
where costs are relatively low.

Does this mean that all your achievements are now of a questionable value, that countries like
Germany cannot compete with countries where wages are extremely low? Certainly not. The fact
is that many other factors besides wage levels go into determining a country's relative appeal to
investors and producers, including: its macroeconomic stability and the predictability of its
exchange rate; the openness of its trade regime and capital account; the productivity of its labor
force; and the transparency of its regulatory framework.

Clearly, Germany scores very well on many counts. In particular, it has a long-established
tradition of low inflation, fiscal prudence, and a strong currency, all of which are conducive to
investment, growth, and employment. It also has a long tradition of industrial excellence--and
nowhere more so than here in Bavaria. I would add that, to Germany's great credit, it has also
managed to absorb the costs of reunification without igniting inflation and come a long way in
correcting the fiscal deficit that reunification helped create.

But as important as macroeconomic stability is, it is not enough. In particular, it cannot
compensate for structural rigidities, especially in the labor market, which make it difficult for the
German economy to adjust to the sectoral shifts in production and employment associated with
globalization. Here, I would emphasize that the weaknesses in the German economy and in those
of its European partners are not the result of globalization. Globalization simply exposes and
intensifies existing structural weaknesses that need to be addressed in any case in order to achieve
faster growth and create more jobs, particularly in countries facing the costs of an aging
population.

The fact is, although German labor productivity is relatively high, relative wages are even higher;
in fact, hourly labor costs in German manufacturing are about 50 percent above the average found
in other G-7 countries. Indeed, this has contributed to the large erosion of competitiveness in the
manufacturing sector--as measured by the rise in the trade-weighted relative unit labor costs
since 1989--and has also put pressures on domestic profits and employment in this important
sector.

Moreover, centralized bargaining on wages and working conditions--along with generous social
transfers paid for by high payroll taxes--have discouraged flexibility in wage setting and work
practices, raised the overhead costs associated with employment, and compressed wage
differentials between high- and low-skilled labor. For example, real wages of low-skilled workers
have risen faster in Germany than in other industrial countries. And, with social security
contributions equivalent to more than 40 percent of gross wages, and marginal income tax rates
steeply progressive, the tax wedge--that is, the difference between an employee's gross
remuneration and his or her after-tax, take-home pay--is one of the highest of all OECD countries.

Likewise, the long duration of unemployment compensation--and the high proportion of a
worker's former wages that it replaces--discourage job seeking. Moreover, the extension of this
system to the new Länder has contributed to an overly rapid convergence of wages between east
and west, particularly high unemployment in the east, and massive social transfers.

Not surprisingly, German employers have tried to take every opportunity to remain profitable and
competitive. This has meant investing in labor-saving, capital-intensive technology and
outsourcing to countries where production is less expensive. As a result of all this, Germany's
structural unemployment has risen, and the associated costs have added to Germany's fiscal
burden. This, in turn, has necessitated higher tax rates, which have further discouraged investment
and job creation.

One could see here the components of a vicious circle. I would prefer to see it as the basic
elements of a tremendous challenge you are facing and, I hope, you will meet: that is, by
streamlining all these features of your regime of compensation and social protection and adapting
them to the new competitive condition of the global markets, while, at the same time, preserving
the unique and exemplary social partnership you have been able to develop so far. A very tall
order indeed! How to respond to it?

Of course, seen from the outside, the key elements of the response can appear straightforward!

First, making wage determination and work rules more flexible. Recent government initiatives to
ease dismissal rules, promote part-time jobs, and extend the uses of fixed-term contracts are
helpful. There have also been some signs of greater flexibility in the workplace from employers
and unions. But more seems necessary, including greater realism in wage negotiations and more
flexibility in the centralized collective bargaining process, so that wage levels better reflect
productivity and differences in skill levels, and wage agreements take account of conditions in
individual firms.

Second, reducing the level of employers' non-wage costs and of disincentives for the unemployed
to seek jobs. One fundamental problem is that the tax burden, particularly marginal tax rates, is
simply too high. At the same time, social security costs have continued to rise. Sweeping reforms
are needed to broaden the tax base, flatten the steep marginal tax schedule, and lower the
statutory corporate tax rate; these would be positive steps toward making the tax system more
competitive and encouraging other countries to carry out similar reforms. Reforms are also
needed to limit the need for further increases in social security contributions as the German
population ages. In this connection, I have no doubt we can look forward to wise proposals from
the Waigel Commission on tax reform and the Blüm Commission on pension reform.

Third, further deregulation is also needed: increased competition--across borders and between
Länder--in areas such as electricity, natural gas, trucking and telecommunications to reduce
firms' input costs. Deregulation is also needed in the financial arena so that financial market
development in Germany is not held back by tax disincentives and cumbersome procedures and
regulations. While some progress has been made in promoting Finanzplatz Deutschland,
including the introduction of short-term government paper and the lowering of reserve
requirements, more will be needed to bolster Germany's appeal as a world financial center.

Let me repeat, Mr. Chairman, it is easy, from the outside, to see what is desirable, what is
probably indispensable. What is more difficult is to achieve it while maintaining the quality of your
social consensus. This will require all the wisdom and leadership that the government, parliament
and social partners have frequently demonstrated in the past.

Having achieved that and maintaining its emphasis on macroeconomic stability, Germany will be
well placed to compete in global markets. For society as a whole, the rewards will be high in
terms of new investment, new jobs, and stronger growth. There will, of course, be short-term
costs for some sectors and some segments of the population. This implies a responsibility for
government and the social partners to help ease the pain of adjustment. But this must be done
through measures that promote adjustment and jobs--not, as is often the case in Europe today,
through measures that primarily aim to protect those who already have jobs, with not enough
regard for the millions of unemployed. In this connection, I would highlight the example of the
Netherlands, which has increased labor market flexibility and thereby reduced unemployment,
while maintaining its social preferences. The task is hard. Your success in finding the right
responses to such questions will be a major contribution to the future of your country and of
Europe.

But what does globalization mean for Europe? In fact, I see a number of parallels between the
benefits that EU countries have already derived from European integration and those they will
reap by embracing globalization. For example, just as Germany and its European partners have
benefited from increased trade within Europe, so too will they gain from continuing to break
down barriers to the exchange of goods and services at the global level. And in the same way that
many non-EU countries have benefited from access to the deeper and broader world markets that
the EU has achieved through European integration, EU members will benefit from the deeper and
broader markets achieved through globalization.

What, then, must Europe do to reap the benefits of globalization? In many respects, the challenges
facing Germany are a microcosm of those facing Europe. Certainly, macroeconomic and monetary
stability are essential. Needless to say, the timely and full completion of the Maastricht process is,
in my view, a "must" for Europe. Let me add that I welcome the stability and growth pact
proposed by Dr. Waigel, which seems to strike a reasonable balance between the need to penalize
lax policies and the need to provide enough flexibility to deal with unexpected developments.

Even beyond the stability pact, I would suggest that the ECOFIN Council of Ministers undertake
a major effort to agree on a set of rules for fiscal transparency and rectitude to make sure that the
same exemplary methods apply to the public sector in all countries of the EU. This would be a
timely measure, not only to strengthen mutual trust in the Union, but also to ensure that EU
practices conform with the Declaration unanimously adopted by the Interim Committee of the
IMF last September, which aims at strengthening fiscal discipline and at enhancing "the
transparency of fiscal policy by persevering with efforts to reduce off-budget transactions and
quasi-fiscal deficits."

But, as in Germany, a strong euro and macroeconomic stability are not enough. Structural
reforms are needed. Social security regimes must be restructured to face demographic changes
and concentrate more social benefits on those who are truly needy. The EU also needs more
flexible markets, especially a more flexible labor market, so that it can adjust to changes in the
global economy, raise its potential rate of output growth, and take advantage of emerging
opportunities in global markets. At present, however, labor market rigidities impede such
adjustment and drive up unemployment. Moreover, the problem could intensify with the
completion of monetary union, since countries will no longer have recourse to exchange rate
changes to adjust to excessive wage increases and other disturbances. Indeed, in the absence of a
flexible labor market, such developments could produce pockets of high unemployment, with
unwelcome fiscal and social effects that, in turn, could create protectionist pressures and
undermine the credibility of monetary policy.

If, on the other hand, the EU remains open and adaptable, it will be able to provide a strong
competitive system. It will have all the potential to create a financial system that is as deep and
efficient as that of the United States. This, in turn, would imply greater opportunities for growth,
a larger international role for the new European currency, and greater influence in world affairs.
The extent to which--and the speed with which--the euro achieves its potential as a key currency
in the international monetary system will depend in large part on the support that fiscal and
structural policies provide. The stability and growth pact is now in place; now structural reforms
will have to be central to the agenda of all those in charge of preparing Europe's future. Central,
but not exclusive. As the prosperity of Europe will be more and more dependent on the stability
and strength of the global world economy, Europe will have to participate more and more in the
global community effort, in the framework of the world financial institutions, to counter the risks
of global instability and marginalization of the poorest.

The International Community's Response to Global Risks

Let me now call your attention to the world community's response to global risks. In fact, in one
way or another, the entire world is actively facing the challenges of globalization.

To begin with, globalization has encouraged more and more countries to embrace macroeconomic
stabilization and structural reform, and they are looking to the IMF for policy advice and financial
support. Our membership has expanded to 181 countries, and we are supporting through our
financing adjustment and reform programs in about 60 of them. This gives you an idea of the
formidable effort of structural adjustment being undertaken worldwide. Many of our newer
members are the transition economies of Eastern Europe and the former Soviet Union, which the
Fund has been helping to reintegrate into the global economy. The results there are still quite
uneven, and a lot remains to be done in many of them, but it is good to see that the more
successful of these countries are now among the most dynamic economies on the continent. This
has brought Europe greater competition, but also new markets, greater stability and, of course,
greater prospects for peace.

Supporting these efforts and developing strong surveillance over them are the traditional tasks of
the IMF. But the globalization of the international financial markets has prompted the IMF to
strengthen its surveillance over member countries' policies, so that emerging problems can be
detected and addressed before the global financial markets force more disorderly adjustment. In
particular, we have sought to develop a more continuous and probing dialogue with member
country authorities. We are also paying greater attention to the soundness of banking systems, to
the sustainability of financial flows, to countries potentially at risk of adverse market reactions,
and to countries where financial market tensions could have major spillover effects.

In addition, recognizing that markets function better when they have adequate information, we are
developing standards to guide members in the dissemination of economic and financial data to the
public.

In this globalized and at times unpredictable world, the IMF cannot limit itself to encouraging its
member countries to undertake policy reforms; it must also be equipped with adequate financial
resources to help them in these efforts. In this connection, work is underway on the Eleventh
General Review of Quotas, and this will remain our top priority. Quotas are the main resource
base for IMF lending, and we are aiming for a substantial increase. I hope that, as always in the
past, Germany will be active in supporting it.

In addition, the G-10 countries, including Germany, along with a number of emerging market
economies and other countries in a strong balance of payments position, are in the process of
establishing parallel financing arrangements complementary to those already in place, so that the
IMF could have access to emergency resources of up to approximately US$50 billion in the event
of a systemic crisis.

But we must also be prepared to fight marginalization worldwide and ready to help our poorest
members' reform efforts on appropriate terms. This is why we are working to ensure that the
IMF's concessional window for its poorest members, the Enhanced Structural Adjustment Facility
(or ESAF), has sufficient resources to continue operating until it becomes self-sustaining early in
the next century. ESAF will also be the vehicle through which the Fund contributes to the joint
IMF/World Bank initiative to relieve the debt burdens of heavily indebted poor countries.

As important as ESAF and the debt initiative are, they will not solve all the poorest countries'
problems of underdevelopment and vulnerability. These countries, especially those in Africa, will
continue to need bilateral support on concessional terms. I know that Germany wants to maintain
and hopefully increase its effort in this area, provided that countries seeking international
assistance--from bilateral or multilateral sources--do their utmost to establish a domestic policy
environment in which this assistance can be used productively. Not only does this require sound
macroeconomic policies and comprehensive structural reform, but also an institutional framework
that gives confidence and security to savers and investors. At the same time, however,
international assistance cannot replace fuller access to world markets, especially for the kinds of
products for which the poorest countries have, or are likely to develop, a comparative advantage:
agricultural and mineral products and basic manufactures.

By maintaining and developing this solidarity effort, our member countries thereby introduce an
essential dimension to their globalization strategy. In the same way that our national efforts to
improve competitiveness must be complemented by efforts to increase the effectiveness of our
support to the most vulnerable in our societies, globalization will only be a success at the world
level if transformed into a new chance for the poorest countries. A lot is at stake here also. As
politicians, you are frequently confronted, as I am--particularly when addressing university
students or NGOs--with the fundamental question of what is the sense in perpetually trying to
increase the competitiveness of our economies. Why? Should we not stop? The only satisfactory
response is this one: we must make our economies more efficient, not only to survive in a harshly
competitive environment, not only to maintain our living standards, but also to be able to show
more solidarity to the most vulnerable people in our countries and to the poorest countries in the
world.

Mr. Chairman, I have left so far unanswered the question--important indeed--of the risks for our
own cultures arising from the universal trend towards cultural homogeneity. As a matter of fact,
as an economist--and to speak the language of the economists--I have no comparative advantage
to address this issue. Let me then, for the sake of comprehensiveness, give you my response as an
ordinary man in the street, as a simple European. It is straightforward.

First, I am so fond of our common culture and such an admirer of the variety of ways in which
throughout the centuries it has provided Europe and the world with new answers to the
permanent questioning of humankind, that I just cannot imagine that it could be threatened by
supermarket cultural products even when they are brought to our homes by the most
sophisticated satellite devices. More importantly, I observe that the task of keeping this cultural
heritage alive and vibrant is very high on the agenda of European leaders at national, regional and
local levels--and rightly so. Let us encourage them in this endeavor, as this is an essential aspect
of the quality of our lives, and it is important that the world be able to continue counting on
Europe to provide it with its own responses to the changing concerns of humanity. Lastly, let us,
as at the best moments in our cultural history, open ourselves to a dialogue of cultures. More than
ever this is a key condition of a civilizational renaissance.

* * * * *

In conclusion, globalization will bring many challenges--to Germany, to the European Union, to
the world and, yes, therefore, to the IMF. The inescapable fact is that the trend toward
globalization affects all countries. Whether the impact of globalization will be for better or for
worse, whether it becomes a threat or an opportunity, will depend on how they respond to its
challenges. I will be happy if I have been able to share with you my confidence that with
appropriate policies Germany and its European partners can not only preserve their earlier
achievements, but build a stronger, brighter future in Europe and the global economy. To
paraphrase what Chancellor Kohl once said about the European Union being the success story of
the twentieth century, let us hope that Europe will be able to play a decisive role in making
globalization the success story of the twenty-first century.